CHANGES IN THE SHIPPING

INDUSTRY AND THE EFFECT

ON PORTS

THOMAS H. TANAKA

SENIOR PORT COUNSEL

PORT OF SEATTLE

AAPA PORT ADMINISTRATION AND LEGAL

ISSUES SEMINAR

OAKLAND, CALIFORNIA

MARCH 8, 2017

1

1. General background of shipping industry today

2. How these issues play out in the leases/use

agreements with MTOs and carriers

3. The intersection of terminal operations, the

Shipping Act, and FMC oversight (Mr. Longstreth

and Mr. Benner to cover)

4. The intersection of politics and the Shipping Act:

community opposition to particular activities and

MTOs (Mr. Longstreth and Mr. Benner to cover)

2

2008-The Great Recession begins.

How was the Pacific carrier business affected?

a. Consumer demand in the US dropped.

b. Slowdown in Chinese manufacturing.

c. Result: Steep drop in cargo volumes crossing the

Pacific.

d. Too many ships chasing not enough cargo.

e. In general, an oversupply of capacity (cargo space)

chasing too little demand (cargo).

f. The consequence of this oversupply is ruinous price

competition on freight rates.

3

How did the carrier industry respond?

One of the key strategies: Cut costs.

Cutting costs occurred in different ways. Two

important strategies:

Achieve economies of scale by building bigger ships

(referred to in the industry as “Ultra Large Container

Ships” or “ULCS.”

4

ULCS achieve greater fuel and labor cost savings

and drives down the throughput cost for containers,

but requires a massive capital investment.

This in turn led to an arms race among competitors.

Once Maersk announced its intention to build ULCS,

other carriers followed suit.

5

Effects on ports:

Bigger ships meant changes within the port industry.

6

One of the key features of the Concorde SST: It

required a much longer runway than conventional jet

planes.

As a result, there were only a handful of airports in the

world where the Concorde could take off and land.

7

The ULCS coming into service present a similar problem to

ports.

There are a limited number of terminals on the west coast that

can handle them.

8

Infrastructure demands posed by ULCS:

• The dock aprons need reinforcing to handle the weight and

mass of the ULCS.

• The container cranes need to be bigger and have a longer

span to reach the containers loaded on the outside edge.

• Because of the need for higher speed and efficiency on the

cranes, these newer larger cranes have greater electrical

needs, meaning the port needs to invest in a new substation.

• ULCS require a 54’ dredge depth, meaning many ports have to

undertake berth deepening.

• For those ports with shallow approaches, that means channel

deepening on the approaches into the terminal as well.

• For ports with bridges without adequate clearance, that

means an expensive exercise to raise the bridge (as in Long

Beach and New York/New Jersey).

9

Other issues created by ULCS:

• ULCS can discharge a large number of containers all

at once. This means the receiving yard needs to

have enough space and equipment to move the

containers quickly.

• This also puts pressure on the gates into and out of

the terminal, creating a higher likelihood of

congestion inside and outside the gates.

• Such congestion creates downstream effects such

as congestion on streets and highways near the

terminal as well as higher levels of air pollution.

• This creates pressure on the terminal operator to

find a way to relieve congestion by extending gate

hours, an expensive proposition.

10

Other measures taken by carriers

Consolidations within the carrier alliances:

2 years ago:

11

2017:

Pacific carriers went from 20 3 years ago to 13 today.

Carrier alliances went from 4 to 3.

12

The effect on ports of the thinning out of the carriers

and the reduction in the number of shipping alliances:

• Larger ships means fewer vessels and therefore

reduced vessel calls at the ports.

• Vessels calling on fewer ports.

• What’s immediately apparent is that on the west coast

we have too many acres of container terminals and

not enough demand for those acres.

• Utilization at many of these terminals, especially in

the Pacific Northwest, is low (50% or less in some

cases).

• Note the terminal closures in Seattle, Portland, and

Oakland as evidence of the disruption.

13

How does this affect leases or use agreements at ports?

Rent:

Seattle and Tacoma historically used land rent as the basis for rent with items such as IY lift fees charged on a volume basis.

A number of ports on the west coast use container volumes as the basis for calculating rent (similar to percentage rent clauses in retail leases).

The marine terminal operator (“MTO”) will pay as rent an amount for each container lifted on and off the facility. There is typically a minimum annual guarantee (“MAG”) of container volume (also referred to as “minimum quantity guarantee” or “guaranteed annual minimum”). If the MTO fails to reach the MAG by the end of the year, the MTO must pay the port the shortfall. If the MTO handles more than the MAG, there’s typically a reduced per container fee.

14

Area-based rent versus volume based rent

Area-based rent:

Pro Con

15

1. Rent is paid 1 month in

advance.

2. It’s easy to see cash flow

into the future.

3. The rent is unaffected if

the MTO’s business is not

prospering—You get the

same rent regardless if

the MTO handles only 1

container or 20 million.

1. There’s no upside—when

MTO business is great,

the rent remains

unchanged.

2. In bad business years,

the MTO may struggle

with rent payments

because there’s no

opportunity to vary the

rent (flip side of Pro #3).

Volume-based rent:

Pro Con

16

1. Provides an opportunity to

increase rent when MTO’s

business is good (and

exceeding the MAG).

2. Depending on how the deal

is structured, it may provide

an incentive to drive more

cargo through the terminal.

1. Rent is paid 1 month (or

more) in arrears.

2. Cash flow is hard to predict

because of variability of

volumes from year to year.

3. Rent is variable based on

container volume.

4. Shortfalls can become

negotiable—temptation to

ask for rollovers.

5. Depending on the situation,

the carriers/MTOs and the

alliances they’re in could

manipulate cargo moving

through different terminals

(see LA/Long Beach).

The Hanjin bankruptcy

All of these elements came into play during the recent

Hanjin bankruptcy in the Ports of Long Beach and Los

Angeles.

17

APM-HMM

Pier A- SSA/MSC

Pier T- TTI/MSC

Other parts of a lease that are affected by these

factors:

The tenant entity. Beware of shell entities like LLCs

that are the proposed tenant. Those entities are

created to shield the parent companies from liability

and they can declare bankruptcy and walk away from

the lease. Get security or put language in place that

will give some protection to the port.

Premises size—automation will reduce the size of the

area needed for container yard activities. Longshore

labor has significant concerns about this so it remains

to be seen how far this will go in the near future.

Lease security. Lease security is at most a speed bump

if a tenant wants to get out of a lease.

18

Improvements. In terms of guaranteeing the long-term

viability of a tenant, make sure they have skin in the

game. The larger the investment the tenant makes in a

facility, the better the long-term prospects for that

tenant to stick things out in tough times. Be careful

about investment in cranes. If title to tenant-purchased

cranes remain with the tenant, those cranes can be

moved.

Assignment and subleasing. This issue raises many of

the same questions regarding the viability of the

tenant. Be wary of assignments to LLCs or other shell

entities. If you give consent to an assignment, make

sure the assignor remains liable for full performance.

Note that a guarantee is not foolproof. In both Seattle

and Long Beach, their leases with Total Terminal

International were guaranteed by Hanjin Shipping,

which filed for bankruptcy and is gone.

19

Questions?

20